Tuesday, October 10, 2006

Necessary but not sufficient

Brad de Long has an article out at Project Syndicate. Our politicians would do well to read it. The article is about how the Mexican economy has developed in the years since NAFTA was signed.

Since NAFTA, Mexican real GDP has grown at 3.6% per year, and exports have boomed, going from 10% of GDP in 1990 and 17% of GDP in 1999 to 28% of GDP today. Next year, Mexico’s real exports will be five times what they were in 1990.

This is as expected- Mexico is right next to the world's largest economy, and has tariff-free and quota-free access to the US market. The macroeconomic portents are excellent

We see great strengths in the Mexican economy – a stable macroeconomic environment, fiscal prudence, low inflation, little country risk, a flexible labor force, a strengthened and solvent banking system, successfully reformed poverty-reduction programs, high earnings from oil, and so on.

The averages, however, mask reality.

But the 3.6% rate of growth of GDP, coupled with a 2.5% per year rate of population and increase, means that Mexicans’ mean income is barely 15% above that of the pre-NAFTA days, and that the gap between their mean income and that of the US has widened. Because of rising inequality, the overwhelming majority of Mexicans live no better off than they did 15 years ago. (Indeed, the only part of Mexican development that has been a great success has been the rise in incomes and living standards that comes from increased migration to the US, and increased remittances sent back to Mexico.)

What could be holding the country back?

To be sure, economic deficiencies still abound in Mexico. According to the OECD, these include a very low average number of years of schooling, with young workers having almost no more formal education than their older counterparts; little on-the-job training; heavy bureaucratic burdens on firms; corrupt judges and police; high crime rates; and a large, low-productivity informal sector that narrows the tax base and raises tax rates on the rest of the economy. But these deficiencies should not be enough to neutralize Mexico’s powerful geographic advantages and the potent benefits of neo-liberal policies, should they?

Apparently they are. The demographic burden of a rapidly growing labor force appears to be greatly increased when that labor force is not very literate, especially when inadequate infrastructure, crime, and official corruption also take their toll.

Sounds familiar? This is not to say that we should roll back the reforms we have undertaken. Just that we need to be more cautious, more humble.

Paul Krugman once wrote a famous article that argued that there was no "Asian Miracle"- the tremendous growth that South East Asia saw in the 80s was the result of the backwardness of those economies. Starting from a small base, they could easily achieve tremendous rates of growth, but diminishing returns would inevitably set in.

India is starting from an even smaller base, and our human capital is even poorer. As we grow, we may eventually find that the educated middle class is employed at wages that are comparable to the the rest of the world, and so no longer enjoy any sort of cost advantage, while the teeming multitudes of illiterate, undernourished peasants find themselves wandering outside the nimbus of the Economic Miracle.